An easy way to do this is with an ISA account. ISAs were created by the government as a way of encouraging people to save. Essentially, rather than paying tax on all your savings, an ISA allows you to save a set amount tax free.
Cash ISA
Up to £5,100 can be invested in a cash ISA, which is essentially a tax-free savings account. The amount you save versus a regular savings account will depend on the amount of cash you put into your and the rate of tax you pay. As an illustration, if you’re a basic-rate tax payer and save £100 a month in an account offering 3% rate of interest, over 10 years you’ll save £13,979 and after 20 £32,766. Now, if you had to pay tax on those savings, you’d lose over £400 in 10 years and £2000 after 20! For long term savings, ISAs clearly save you a small fortune.
Stocks and Shares ISA
If you’re looking to get a little more from your investments (with subsequently more risk) you can still do so in a tax-efficient manner with a stocks and shares ISA.
Stocks and shares ISAs work in a different way to cash ISAs. Firstly they’ll need to be set-up and managed, just like any other investment vehicle. Also, not all your income will be tax-free- indeed, most investments will only be less taxable if you’re already a higher rate tax payer. To benefit as a basic rate payer, you need to put money into interest-bearing investments, such as corporate bonds.
For those who would normally pay capital gains tax, the benefits of a stocks and shares ISA can be significant. Given that you could hope for returns of 7% from good investments, a £100 a month investment could be worth over £50,000 after 20 years- all completely tax free! Of course this is only an illustration – investments can go down as well as up – but they are certainly worth considering if you were planning to invest anyway.
Despite being tax-free, ISAs are not suitable for everyone. For example, they have strict limits about how much money you can invest over the course of the tax year – regardless of how much you take out. If you put £5,000 into an account and take it out again, you can’t then re-invest it in the same tax year as this will push you over the limit. If you like to move your money around a lot, you would be much better off with normal saving accounts or investments where you can withdraw money without penalties.
With public finances in such a bad state, most economists believe that taxes will rise after the next election, so there’s never been a better time to make sure your investments and savings are operating in a tax-efficient manner. Make sure you speak to your bank or IFA for advice about the best deals for you.